Bloomberg's Andy Mukherjee: Asian Stocks May Ride Out Tough 2005 in Style

Asian Stocks May Ride Out Tough 2005 in Style
By Andy Mukherjee

Dec. 27 (Bloomberg) -- For investors fretting over the many risks to the world economy next year, here's a pleasant prospect: Asian stocks may ride out a turbulent 2005 in style.

For Asian equities to put up a good show in the face of a declining dollar, cooling Chinese demand and still-high oil prices, the region's central banks need only lift the lid off local money supply, giving households and companies more spending power.

Make no mistake, a declining dollar and slackening U.S. demand probably will bring no cheer to investors in Taiwan and South Korean semiconductor and electronics manufacturers, which are facing margin pressures. Taiwan's exports rose at their slowest pace in 14 months in November. At the same time, a spurt in Asia's money supply -- a weapon the region's central banks have yet to fire -- could be good news for banking, property and other stocks dependent on domestic demand.

``We like domestically focused stocks in Asia,'' says T.J. Bond, chief Asia-Pacific economist at Merrill Lynch & Co., who says he favors banks and telecommunications shares because ``the Asian consumer in Japan, in China and the rest of the region will rise to the challenge in 2005.''

The key to stoking Asia's consumption and investment demand lies with the region's central banks, which have for the past two years resisted appreciation in their currencies by lining up their reserves with dollars brought in by exporters, investors and speculators. Then, to make sure the money they released into the banking system in order to purchase the dollars wasn't inflationary, they sold bonds to ``sterilize'' the cash. The net effect was that local demand in Asia remained on a tight leash.

Credit Growth

In a recent report, Sailesh Jha, Dong Tao and other Asia economists at Credit Suisse First Boston cite the example of Singapore. Between 2000 and 2003, net foreign assets of the Monetary Authority of Singapore, as a ratio of gross domestic product, jumped by a whopping 15.4 percentage points.

Yet, thanks to aggressive sterilization, the central bank's net domestic assets, as a ratio of GDP, shrank 14 percentage points in the same period. As a result, the ratio of monetary base to GDP, a measure of new money created by the central bank, expanded a measly 1.4 percentage points.

``The anemic pickup in the monetary base has been one of the key reasons why credit growth has yet to explode in Singapore, in spite of an expected 8.4 percent GDP growth in 2004,'' the CSFB researchers say. Singapore isn't alone. In Taiwan, the entire 35 percentage point increase in the central bank's foreign assets between 2000 and 2003 was nullified by a fall in the bank's local assets, reducing base money growth as a ratio of GDP to zero.

Sterilization Costs

Why should it be any different in 2005? For one, Asian central banks will be able to sell more local-currency bonds only by paying higher yields -- much higher than what they earn on their foreign assets. Second, a weakening dollar will drive more overseas capital into Asia to gain from currency appreciation.

``Overburdened by accelerating capital flows to their economies and domestic investors' tolerance for buying domestic government securities diminishing, Asian central banks may reduce their pace of sterilization in 2005, '' says the CSFB report. More money sloshing about in the Asian banking system in 2005 will help fuel consumer spending on property, cars, consumer durables and financial assets.

From an Asian central bank perspective, it would be good to have the American consumer buying the region's exports of cars and computers. Still, it won't be the end of the world if the overspent U.S. consumer stays home. Asia's own consumers will pick up some of the slack.

Asian Consumer

``Even if Asia is set to decelerate,'' say Sebastien Barbe and Claire Dissaux, economists at Calyon, the investment banking arm of France's Credit Agricole SA, ``it should continue to do much better than Europe. We see non-Japan Asia's GDP increasing by 6.7 percent year-on-year in 2005, compared with only 1.7 percent for Europe.''

Most Asian nations can afford to expand their monetary base, except China and India, where inflation is already a headache and more liquidity in the banking system is only going to make matters worse.

Asian equities may be the dominant investment theme in 2005. ``We're big believers in Asia,'' says Emiel Van den Heiligenberg, who oversees $97 billion in assets at Fortis Investments in Amsterdam. ``The second motor of the world economy has been Asia. We see a lot of good developments in the domestic economy in Asia: domestic demand is growing, the political situation on average is improving, currencies are strengthening.''

That will surely be a pleasant prospect for investors in a volatile 2005.